Stochastic Dominance and Cumulative Prospect Theory
We generalize and extend the second-order stochastic dominance condition for expected utility to cumulative prospect theory. The new definitions include preferences represented by S-shaped value functions, inverse S-shaped probability weighting functions, and loss aversion. The stochastic dominance...
| Veröffentlicht in: | Management Science. - Institute for Operations Research and the Management Sciences, 1954. - 52(2006), 9, Seite 1409-1423 |
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| Format: | Online-Aufsatz |
| Sprache: | English |
| Veröffentlicht: |
2006
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| Zugriff auf das übergeordnete Werk: | Management Science |
| Schlagworte: | second-order stochastic dominance cumulative prospect theory value function probability weighting function Behavioral sciences Mathematics Economics |
| Zusammenfassung: | We generalize and extend the second-order stochastic dominance condition for expected utility to cumulative prospect theory. The new definitions include preferences represented by S-shaped value functions, inverse S-shaped probability weighting functions, and loss aversion. The stochastic dominance conditions supply a framework to test different features of cumulative prospect theory. In the experimental part of the paper, we offer a test of several joint hypotheses on the value function and the probability weighting function. Assuming empirically relevant weighting functions, we can reject the inverse S-shaped value function recently advocated by Levy and Levy (2002) in favor of the S-shaped form. In addition, we find generally supporting evidence for loss aversion. Violations of loss aversion can be explained by subjects using the overall probability of winning as a heuristic. |
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| ISSN: | 15265501 |